How American Express Makes its Money

Alphabet Inc. (GOOG) is the archetype of a company that earns goodwill (in the non-accounting sense) and good karma by creating remarkable products and services, then releasing them to the public without charge. But if any company deserves accolades for giving the store away, it’s the one that’s been doing it for more than half a century — American Express Co. (AXP). Name another corporation that offers cash, flights, theme park admission, rental cars, hotel upgrades, gift cards — all in exchange for you doing absolutely nothing. Nothing short of buying stuff that you presumably would have bought anyway, that is. And unlike Google, American Express doesn't add your personal information to an invasive and all-encompassing database. American Express gives, you get. It’s the most altruistic company on Earth.

On June 27, 2018, American Express benefited greatly from a Supreme Court ruling which stated that vendors can't nudge customers towards using one type of debit or credit card over another. American Express typically charges higher fees, making it in merchants' best interest to urge customers to use other cards.

American Express reported $10 million in revenue for Q2 of 2018 (up 9% from same quarter last year) with a net income of $1.6 billion.

The Economics of Late Fees and Interest

And the only reason the entire business model stays viable is that American Express has tens of millions of cardholders who don’t understand how it works, and who demonstrate this by failing to pay their bills on time.

How does a company earn $2.7 billion in annual profit — down from last year's $5.4 billion— with such an intangible service? We won’t explain the basics of how credit cards work right here, but the late payers make it easy for the rest of us to ride free. With 107 million American Express cardholders charging almost $1.085 trillion in 2017, that’s a lot of revolving credit. (For related reading, see: How Credit Card Delinquency Works.)

Annual Fees, Too

Mind you, there’s more to American Express’s strategy than just collecting interest from tardy customers. For one thing, the company is unusual among credit card issuers in that it charges cardholders just for the privilege of possessing many of its cards. Annual fees can reach up to $550 for American Express’s publicly available cards, and to $2,500 for its legendary but very real invite-only Centurion card. The company does offer several free co-branded and entry-level cards.

Most of American Express’s gross income is categorized as “discount revenue,” better known as merchant fees. Famously, American Express earns money by charging high merchant fees, higher than those its competitors charge. As to why merchants willingly accept American Express and thus pay the high fees, the average American Express cardholder is relatively wealthy, or at least relatively profligate. It’s worth the increased fees to get said customers in the door. Since the company’s self-perpetuating cycle of cachet allows it to charge merchants more than MasterCard Inc. (MA) and Visa Inc.(V) do, and since American Express’s comparably affluent cardholders buy more goods and services than do their cohorts closer to the mean, it’s worthwhile for merchants to court American Express.

Both Sides of the Transaction

In the past, the majority of American Express cards charged no interest. You had to pay your bill in full every month, or the company would close your account and send a collection agency after you for the balance. This stands in blatant contrast to the modus operandi of other credit card companies, which charge interest high enough to keep cardholders beholden for decades. American Express had a different strategy — hook the merchants, not the cardholders. (With the advent of American Express’s new Blue Cash and related cards, now the idea is to hook the cardholders too.) The percentage of each transaction is tiny, but a tiny percentage multiplied by $952 billion in annual charges is enough to turn a more than a handsome profit.

Continued Growth

American Express divides its business services into four main segments: U.S. card, international card, global commercial, and global network & merchant. (“Global” is “international” plus “the U.S.” in AmEx-speak.) Growth in both card segments continues to increase, albeit more modestly than in previous years. Net interest income earned from U.S. consumer services rose to $5.7 billion last year, and 1.02 billion internat. This might sound counterintuitive — shouldn’t the rest of the world be growing faster than the U.S.? While revenue increased internationally, it cost the company more to market and offer rewards outside its country of origin.

The Bottom Line

Consumers like novelty, reliability, variety, and other subjective qualities. But what really keeps them coming back for more is convenience. For cardholders, having an American Express card is a simple and elegant way to avoid carrying cash, and to have disputes resolved quickly and favorably. For a merchant, taking American Express offers prestige and customer service that few others can match. Taking both its customer bases into account, American Express’s business has grown exponentially since its humble 1958 debut. With the company now breaking decades of precedent by finally issuing true credit cards (that carry revolving credit, as opposed to pay-in-full charge cards) and doing so through banks, the safe bet is that American Express will remain the favorite way to pay among the rich and aspiring for decades to come.

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